STEM help / Calculation framework

10.3.11 Financial charges: interest, tax and dividends

The effects of the cost of borrowing, tax and dividends are calculated for the network as a whole. These costs do not affect the charge per connection or tariffs for individual Services.

Interest

Global interest rates for deposit, investment, borrowing and overdraft are defined as Interpolated Series – see 10.3.33.7 Interpolated Series. The first two apply to surplus cash, which is split between short-term deposits (such as marketable securities) and long-term investments, according to the Long-Term Investment Proportion. The last two apply to long-term borrowing and any overdraft.

If your model includes explicit Debt Facilities, then any borrowing over and above these defined credit facilities and limits is assumed to be covered by a fully flexible instrument (‘float’) identified with the global Borrowing Rate input.

Each individual interest item in year n, In, is calculated from the corresponding average balance as:

where

rn = Deposit, Investment, Borrowing or Overdraft Rate in year n

Bn = balance at the end of year n for Cash Deposits, Investments, Long-Term Borrowing or Overdraft

Bn–1 = Initial Cash Deposits, Investments, Long-Term Borrowing or Overdraft input.

The Net Interest Expense result is the difference between the two following results:

Thus the Pre-Tax Profit in year n, Pn, is calculated as:

Tax

A global Tax Rate is defined as an Interpolated Series – see 10.3.33.7 Interpolated Series. Tax is calculated as a corresponding proportion of profit after interest, with some scope for tax relief for prior losses. However, it is commonplace for tax to be paid either wholly or partly in arrears, and a further time-series input, Current Year Tax Proportion, allows you to specify what proportion of tax, if any, should be paid in the current year. Thus we calculate three tax results:

  • Tax Charge, the tax to be paid for the current year’s activities, which is shown on the profit and loss statement
  • Tax Payable, the amount left to pay in arrears the following year, which appears as a current liability on the balance sheet
  • Tax Paid, the amount of tax paid during the year (plus Tax Payable from the previous year), which features in the cashflow.

The Tax Charge in year n, Tn, is calculated on profit after interest as:

where

Pn = Pre-Tax Profit in year n

tn = Tax Rate in year n,

giving Tax Paid, TAn, and Tax Payable, TBn, both in year n, as:

where

un = Current Year Tax Proportion in year n

TB–1 = Initial Tax Payable input,

assuming that Pre-Tax Profit is positive or input Tax Relief Regime = Immediate. If Tax Relief Regime = Limited or Unlimited, the Tax Charge may be reduced if there is any outstanding tax relief.

Then the Net Profit in year n, Qn, is calculated as:

Tax Relief for Loss

It is common practice for a business which makes a loss for a number of years to be able to claim ‘tax relief’, so that when it goes into profit it is not immediately liable to pay tax. The Tax Relief Regime input presents a choice of four different models for handling tax relief:

None: the Tax Rate is only applied to positive Pre-Tax Profit when calculating the Tax Charge, and no tax relief is available. This is the default.

Immediate: the Tax Rate is applied to Pre-Tax Profit, even if negative, in which case there will be a negative Tax Charge. Such a charge – corresponding to a credit from the government – may be appropriate where the model represents only part of the organisation’s operations, and losses in the operation being modelled can be offset for tax purposes against profits in other operations.

Limited: losses are accumulated in years when Pre-Tax Profit is negative, for a maximum number of years specified by a new input, Tax Relief Years. In years when Pre-Tax Profit is positive, any remaining losses are offset against profit, starting with the oldest. A Tax Charge is only levied once all losses are exhausted.

Unlimited: losses are accumulated indefinitely when Pre-Tax Profit is negative, and offset against profit when Pre-Tax Profit is positive, as above.

The Prior Annual Loss time-series input allows you to specify historical losses for the years immediately before the start of the model. For example, with Tax Relief Years of 5 and Prior Annual Loss constant at 100, the total accumulated losses available in year zero will be 500. Even with Tax Relief Regime = Unlimited, the historical data are limited to the last five years. Ignoring the actual profit or loss in the following years, the loss carried forward will reduce by 100 each subsequent year if Tax Relief Regime = Limited, whereas with Unlimited it will remain at 500.

Note: Tax relief is implemented as a series of derived results, supporting limited accumulation of losses for up to five years or unlimited accumulation indefinitely. If you need to accumulate losses for more than five years for limited tax relief, it is fairly straightforward to define the necessary additional results – see 5.17 Defining results.

Dividends

A global Dividend Rate is defined as an Interpolated Series – see 10.3.33.7 Interpolated Series. Dividends are calculated as a corresponding proportion of profit after interest and tax. In line with the calculations for tax, a further time-series input is provided, Current Year Dividend Proportion, which allows you to specify what proportion, if any, should be paid as interim dividends in the current year, and there are three corresponding dividend results:

  • Dividends Declared, the dividend to be paid on the current year’s activities, which is shown on the profit and loss statement
  • Dividends Payable, the amount left to pay in arrears the following year, which appears as a current liability on the balance sheet
  • Dividends Paid, the amount of dividends paid during the year (plus Dividends Payable from the previous year), which features in the cashflow.

Dividends Declared in year n, Dn, are calculated on profit after tax as:

where

dn = Dividend Rate in year n

Qn = Net Profit in year n,

giving Dividends Paid, DAn, and Dividends Payable, DBn, both in year n, as:

where

vn = Current Year Dividend Proportion in year n,

DB–1 = Initial Dividends Payable input

assuming Net Profit is positive. Otherwise there will be no Dividends Declared, but there might be some outstanding Dividends Payable.

Finally the Retained Profit in year n, Rn, is calculated as:

 

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